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SEC Approves Revised Rules for Whistleblowers

Source: NY Times - Edward Wyatt

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Posted on 26 May 2011

The Securities and Exchange Commission (SEC) narrowly approved rules on Wednesday to create a $300 million whistleblower program.

Supporters of the program said it would help the agency crack down on wrongdoing, but opponents contend it would actually hamper the ability of companies to police themselves.

The final rules, which were approved by a 3-to-2 vote, included several changes from rules first proposed by the SEC last year after passage of the Dodd-Frank regulatory law that provided for the program. One of the changes included a potential bonus if corporate employees first report suspected wrongdoing through their company’s internal compliance system.

Business groups worried that bypassing internal reporting procedures would undercut the multimillion-dollar investments they have made to strengthen their compliance departments in response to tougher post-Enron corporate rules and laws, including the Sarbanes-Oxley Act.

But the new rules still drew complaints as opponents contended that the program would still require a whistle-blower to report wrongdoing to the SEC as well as to a company’s internal systems in order to guarantee eligibility for a reward.

Mary L. Schapiro, the SEC chairwoman, said the rules were important to the agency because it has limited resources and therefore needs “to be able to leverage the resources of people who may have first-hand information about potential violations.”

The whistleblower provisions were written partly in response to the agency’s failure to uncover Bernard L. Madoff’s Ponzi scheme and other similar frauds.

Previously, the SEC had authority to reward tipsters only in insider trading cases and was limited to paying 10 percent of the penalties collected.

The new rules provide for payment of 10 percent to 30 percent of the collected amount when the sanctions imposed by regulators exceed $1 million.

In determining the size of the reward, the agency can take into account the value of the tips offered and a whistleblower’s cooperation with the company’s internal notice program.

The changes from the original proposals, which attracted 240 comments and more than 1,300 form letters, were not enough for the SEC’s two Republican commissioners, Kathleen L. Casey and Troy A. Paredes, who both voted against the rules.

“The final rule permits a whistleblower to knowingly bypass a company’s good-faith attempts to identify and investigate alleged violations,” Mr. Paredes said, and does not require the SEC to reward an employee for first going to his employer with a tip. Rather, the rule says the agency “may increase” the reward based on that cooperation.

Ms. Casey noted that companies could usually investigate wrongdoing far more quickly than the SEC, and that by giving tipsters an incentive to go to the commission, frauds could be allowed to grow worse because of the slower response.

The new program also “significantly overestimates our capacity to effectively triage and manage whistleblower complaints,” Ms. Casey said. Predicting that the number of complaints flowing into the SEC will grow “as we begin writing some very large checks,” Ms. Casey said “too little has been done here to anticipate” that result.

Robert Khuzami, the SEC’s director of enforcement, said the SEC had seen “an uptick” in the number of complaints since the Dodd-Frank Act went into effect last July, but there had not been a flood. The quality of the tips has improved as well, he said, and they are often accompanied with detailed corroboration.

Sean McKessy, the chief of the SEC’s new whistleblower office, said the agency’s ability to separate out credible tips also will be enhanced by requirements that potential whistleblowers identify themselves as seeking a possible reward, and providing a sworn statement, under penalty of perjury, that the information is true.

The United States Chamber of Commerce, which lobbied against the proposed rules, expressed continued dismay. “We have already seen trial lawyers running advertisements and training seminars on how to profit from bounty programs adopted under these rules,” the chamber said in a statement.

The new rule will lead lawyers to urge whistle-blowers to keep their company in the dark, it said.

That statement, however, appears not to take into account provisions that allow the SEC to increase a bounty if a whistleblower notified a company’s compliance program first.

Erika A. Kelton, a lawyer with Phillips & Cohen in Washington, said that in more than two decades representing whistleblowers, her firm has found that “in almost all cases, employees have reported their concerns about misconduct and fraud to managers and supervisors first.”

“It has only been after they have been retaliated against for doing so that they have come to us,” Ms. Kelton added.

The rules also exclude certain people from being eligible for the awards, including people involved in the wrongdoing, lawyers who gain privileged information from clients, foreign government officials and compliance and internal audit employees.

There are exceptions, however. Compliance and internal audit workers or public accountants, who see that a company has not acted on tips of wrongdoing, could be eligible, as could an informant who believes that a company is trying to obstruct an investigation.


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